[Federal Register Volume 61, Number 88 (Monday, May 6, 1996)]
[Notices]
[Pages 20304-20306]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11230]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37152; File No. SR-PTC-96-02]
Self-Regulatory Organizations; Participants Trust Company; Notice
of Filing and Order Granting Accelerated Approval of Proposed Rule
Change Establishing on a Permanent Basis the Margin and Pricing
Methodology for Collateralized Mortgage Obligations
April 30, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on March 8, 1996, the
Participants Trust Company (``PTC'') filed with the Securities and
Exchange Commission (``Commission'') the proposed rule change (File No.
SR-PTC-96-02) as described in Items I and II below, which Items have
been prepared primarily by PTC. The Commission is publishing this
notice and order to solicit comments from interested persons and to
grant accelerated approval of the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1) (1988).
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[[Page 20305]]
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The proposed rule change establishes on a permanent basis the
margin and pricing methodology utilized by PTC for collateralized
mortgage obligations (``CMOs'') that are eligible for deposit or that
may become eligible for deposit at PTC.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, PTC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. Summaries of the most significant aspects of such
statements are set forth in sections A, B, and C below.\2\
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\2\ The Commission has modified the text of the summaries
prepared by PTC.
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A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
The purpose of the proposed rule change is to establish a permanent
methodology to formulate the percentage (i.e., margin) to be deducted
from the market value of CMOs that are eligible for deposit or that may
become eligible for deposit at PTC.\3\ The proposed margin and pricing
methodology is substantially the same as the current margin and pricing
methodology except for one variation that is proposed as a result of
PTC's research and analysis of additional data compiled in the period
since the temporary approval was granted.
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\3\ PTC's current CMO margin and pricing methodology was
approved by the Commission on a temporary basis through April 30,
1996, in order to allow PTC to make technical enhancements that
enabled PTC to use and compare data from two pricing vendors and
also enabled PTC to further evaluate the results of the CMO pricing
and margin methodology as enhanced. Securities Exchange Act Release
No. 35641 (April 24, 1995), 60 FR 21228 [File No. SR-PTC-95-03]
(order approving proposed rule change on an accelerated basis).
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Margin under PTC's Rules
Under PTC's rules, a certain percentage (''applicable percentage'')
of the market value of securities is included in the computation of
participants' Net Free Equity.\4\ Net Free Equity represents PTC's
calculation of the amount of excess equity available in a participant's
account which PTC may borrow against or liquidate in the event a
participant's debit balance is not satisfied at the end of the day. Net
Free Equity of zero or greater is required to be maintained by
participants in each of its agency, pledge, or proprietary accounts in
order for transactions to be processed.\5\
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\4\ As set forth in PTC Rules, Article II, Rule 9, Net Free
Equity is calculated as the sum of (a) the cash balance in the
account; (b) the market value of securities in the account less the
applicable percentage; (c) the value of the optional deposits to the
Participants Fund which are allocated to that account (optional
deposits to the Participants Fund are deposits that exceed the
minimum deposit required pursuant to PTC's rules and procedures);
and (d) 20% of the mandatory deposits to the Participants Fund for
the master account (mandatory deposits to the Participants Fund are
minimum deposits required to be deposited into such fund pursuant to
PTC's rules and procedures) minus (e) ``reserve on gain.'' Reserve
on gain means (1) the contract value credited to the cash balance of
a delivering participant or limited purpose participant over the
market value of securities credited to the transfer account
associated with the account of the receiving participant or (2) the
market value of securities credited to the transfer account
associated with the account of a receiving participant over the
contract value credited to the cash balance of the delivering
participant or limited purpose participant.
\5\ PTC Rules, Article II, Rule 13, ``Transfers of Securities.''
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By including only a portion of the market value of securities in
Net Free Equity, PTC attempts to limit the risk caused by fluctuations
in the market value of these securities. For example, for Government
National Mortgage Association (``GNMA'') single-class securities other
than construction, project, and mobile home securities, margin is set
at five percent, which is a rate that exceeds these securities' largest
historic consecutive two-day downward price movement. GNMA
construction, project, and mobile home securities have a higher margin
to reflect their reduced liquidity.\6\
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\6\ Securities Exchange Act Release No. 33840 (March 31, 1994),
59 FR 16672 [File No. PTC-93-04] (order approving proposed rule
change).
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CMO Margins
CMOs that are currently eligible for deposit at PTC are GNMA
REMICs, Department of Veterans Affairs (``VA'') REMICs, and certain
Federal Home Loan Mortgage Corporation (``FHLMC'') and Federal National
Mortgage Association (``FNMA'') REMICs. Unlike GNMA single-class
securities, CMOs are multiple-class mortgage cash flow securities which
redirect the cash flow from an underlying standard mortgage-backed
security, such as a GNMA security, and which allow the CMO issuer to
create classes or tranches with many different interest rates, average
lives, prepayment sensitivities, and final maturities.
To establish margins for CMOs, PTC uses a model which takes into
account the unique characteristics of each tranche to predict its
potential price movement. The parameters of the model include the
current price of the security, the prepayment assumptions, and the
corresponding Treasury yield curve. PTC subjects each CMO tranche to a
stress test to determine its response to yield changes in order to
assign each tranche an appropriate margin.
Currently, margins are based on a fifty basis point upward movement
in the yield of the underlying Treasury securities for CMO tranches
that exhibit positive effective duration (i.e., tranches which rise in
value with falling interest rates) or a fifty basis point downward
movement in the yield of the underlying Treasury security for CMO
tranches that exhibit negative effective duration (i.e., tranches which
decline in value with falling interest rates). CMO tranches that are
not modeled by PTC's pricing vendors are margined at one hundred
percent, and the minimum margin for any CMO tranche is five percent.
All margins are reevaluated at least quarterly. In addition,
margins are reevaluated any time there is a shift of one hundred basis
points or more on any point of the Treasury yield curve for the
applicable CMOs and for any CMOs that experience a one-day price
decrease in excess of fifty percent of the assigned margin.
Proposed New Margin Methodology
Because PTC anticipates that additional issues of FHLMC and FNMA
CMOs may become eligible for deposit at PTC, it has extended its
analysis of historical shifts in Treasury yield decreases. As a result
of this analysis, PTC proposes to increase the basis points used for
margin calculation for CMOs that exhibit negative effective duration
from fifty basis points to one hundred basis points.\7\ Therefore, PTC
has requested permanent approval of its methodology to establish
margins for CMOs based upon the maximum percentage decrease resulting
from a fifty basis point upward movement in the yield of the underlying
Treasury security for CMO tranches that exhibit positive effective
duration or a one hundred basis point downward movement in the yield of
the underlying Treasury security for CMO tranches that exhibit negative
effective duration.
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\7\ One hundred basis points corresponds to the largest actual
decrease in Treasury yields over the most current ten year period.
The largest actual decrease in Treasury yields over the most current
ten year period occurred when the two-year Treasury yield declined
99.5 basis points between the days before and after the stock market
break on October 19, 1987 (comparing Friday, October 16, 1987, with
Tuesday, October 20, 1987).
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[[Page 20306]]
The increase in the basis points used for CMOs that exhibit
negative effective duration does not affect the margins of the CMOs
currently on deposit at PTC because the CMO tranches that would decline
in value assuming a one hundred basis point decline in the yield of the
underlying Treasury security are interest only (``IO'') tranches or
tranches which have IO like characteristics. These securities are not
currently priced by PTC's pricing vendors and accordingly are assigned
a value of zero on PTC's system.\8\ However, PTC anticipates that as
additional issues become depository eligible at PTC and PTC's pricing
vendors are able to provide prices for such issues, some of these
issues may include tranches which are sensitive to a one hundred basis
point decline.
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\8\ Since temporary approval for the current CMO margin and
pricing methodology was granted, PTC has completed the system
enhancements necessary to use and compare data from two pricing
vendors. CMO prices are established by defaulting to the lower of
the two in the event of any discrepancy.
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PTC believes that the proposed rule change is consistent with
Section 17A(b)(3)(F) of the Act \9\ and the rules and regulations
thereunder because it facilitates the prompt and accurate clearance and
settlement of securities transactions and provides for the safeguarding
of securities and funds in PTC's custody or control or for which PTC is
responsible.
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\9\ 15 U.S.C. 78q-1(b)(3)(F) (1988).
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B. Self-Regulatory Organization's Statement on Burden on Competition
PTC does not believe that the proposed rule change imposes any
burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
PTC has discussed the proposed margin methodology with its Risk
Management Committee, which is comprised of participant
representatives. PTC has neither solicited nor received written
comments from participants or other interested parties on this proposed
rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Section 17A(b)(3)(F) of the Act \10\ requires that the rules of a
clearing agency be designed to assure the safeguarding of securities
and funds in the custody or control of the clearing agency or for which
it is responsible. The Commission believes that the proposed margin and
pricing methodology utilized by PTC for CMOs is consistent with this
obligation.
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\10\ 15 U.S.C. 78q-1(b)(3)(F) (1988).
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The Commission previously approved PTC's current margin and pricing
methodology for CMOs on a temporary basis in order to allow PTC further
time to evaluate the methodology and to take steps to address any
concerns which existed with respect to the methodology. During the
temporary approval period, PTC has provided information to the
Commission describing the steps taken by PTC to improve the margin and
pricing methodology including finalizing arrangements with a second
pricing vendor for daily pricing and stress test analysis. Because PTC
believes it has made all the changes that its research and analysis
conducted during the temporary approval period revealed needed to be
made, PTC has decided to request permanent approval of the margin and
pricing methodology.
PTC's margin and pricing methodology helps ensure that in
establishing CMO margins, PTC takes into account the unique
characteristics of each CMO tranche. Furthermore, PTC's reliance on two
pricing sources should provide PTC with timely and accurate price
information. The resulting margins established for CMOs that are
eligible for deposit or that may become eligible for deposit at PTC
should afford PTC sufficient protection in the event it becomes
necessary for PTC to borrow against or liquidate these assets to
satisfy a participant's debit balance that is not satisfied at the end
of the day. In addition, increasing the basis points used in
calculating margins for CMOs that exhibit negative effective duration
from fifty basis points to one hundred basis points should result in
more conservative margins for these securities and thereby should help
to limit PTC's risk resulting from fluctuations in the market values of
these securities.
PTC has requested that the Commission find good cause for approving
the proposed rule change prior to the thirtieth day after the date of
publication of notice of the filing. The Commission finds such good
cause for so approving the proposed rule change because accelerated
approval will allow PTC to continue employing its margin and pricing
methodology without disruption of service prior to the expiration of
the current temporary approval on April 30, 1996. Furthermore, the
Commission did not receive any comment letters during the comment
period before it granted temporary approval or during the temporary
approval period and does not expect to receive any during the present
comment period. The staff of the Board of Governors of the Federal
Reserve System (``Board of Governors'') has concurred with the
Commission's granting of accelerated approval.\11\
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\11\ Telephone conversation between John Rudolph, Board of
Governors, and Ari Burstein, Division of Market Regulation,
Commission (April 15, 1996).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Section, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such filing will also be available
for inspection and copying at the principal office of PTC. All
submissions should refer to file number SR-PTC-96-02 and should be
submitted by May 27, 1996.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-PTC-96-02) be and hereby is
approved on an accelerated basis.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR. 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-11230 Filed 5-3-96; 8:45 am]
BILLING CODE 8010-01-M
